Having started in funds management right after the ’87 crash, Anton Tagliaferro thought he had a good grip on the business cycle. Economies boom, stock prices go up, interest rates increase and then an endogenous shock caused by a bubble happens, leading to a recession and lower prices. That’s the way it usually goes, but COVID-19 surprised even him.
“It’s quite an unusual period because in a sense it's an economic boom in some sectors but a depression in other sectors like travel and hotels, so it’s a confusing time.”
But he believes that the boom in those hot sectors is unsustainable, calling out Australian technology stocks – especially Buy Now, Pay Later and e-commerce companies – as pockets of irrational exuberance driven by record-low rates, bored traders, and unnatural government actions.
Anton goes as far as to say that the “vast majority” of Australian technology companies emerging from this recent boom will not survive as they do not possess the indomitable assets and moats that the U.S. internet giants do.
Instead, Investors Mutual is sticking to its guns; skipping out on the growth hype and snapping up quality companies generating profits and dividends from unique assets. Because as Anton suggests, when the storm comes, only the strongest boats will survive.
Key discussion points:
- Inconsistency of government actions & market outlook (3:26)
- The bubble brewing in ASX technology stocks (8:29)
- Defining quality in this environment and stocks IML likes (14:18)
- The uncertain future for A-REITs (17:48)
- The big lesson from Myer (20:02)
- Anton's words of wisdom for worried investors (22:54)
Watch the video or access the Q&A version of this interview below.
How bad is COVID-19 relative to what you’ve experienced previously?
Well, this one's a very unusual crisis, put it that way, because this is the first crisis that I've lived through and, in fact, many people have lived through that's actually being caused by the actions of government because of a health issue. So it's very unusual.
If you look at previous crises, there's been normally an excess and interest rates are put up or a bubble forms and central banks tighten up rates or whatever, and then that normally causes some sort of financial crisis which occasionally turns into an economic crisis. This is very different. This has been actually caused, as I said, by the actions of government. Now, obviously, they didn't purposely want to put the economy into recession, but obviously their actions in terms of trying to contain the pandemic have led to a recession of sorts.
Again, I think it's worth pointing out that it's a recession of sorts because it's quite a very different recession because, again, what's happening in this recession, I and put inverted commas, because some sectors, the airline industry, hotels, et cetera, they're down sort of 90-100% and then other sectors like some retail, Bunnings and whatever, they're actually up.
So net-net, it's a recession but, again, it's a very uneven recession because as I said, some sectors have just been absolutely smashed because of the restrictions and some sectors are actually benefiting because:
- The government has pumped so much money into the system, and
- People are using that money in alternative ways. For example, instead of travelling, they're going out and buying a new sofa from Nick Scali or whatever.
And so is that the thing that's surprised you the most?
Well, as I said, we've had the actions of government that have put us into this situation in a sense, and I think government feels responsible now for sort of trying to go drag us out of it. As I said, on the one hand, the government's put all these restrictions in place. On the other hand, the government's spending like there's no tomorrow to try and get us back to sort of GDP growth.
In Australia/NZ we’re easing restrictions but the rest of the world seems to be going the other way. How is that playing into your market views?
Well, that's not quite right. In Europe - in Europe, people are flying around. International airports are open and people are flying around. UK, Britain, France, they're flying around.
But is there the confidence that this is sustainable given the second wave?
Well, they're flying around and actually it's interesting again if you look at Europe, the case numbers are up greatly, but the number of deaths is way below. So, the case numbers are way above where they were in March, but the deaths are well below where they were in March. And that's because what's happened in Europe, people have been told if you're old, if you're vulnerable, stay home. If you're young, be a bit careful, but you can go out, you can go back to the office.
Again, I think that's the other thing about this whole situation is how every government has handled it differently and I mean in the US every state has handled it differently. In Australia, again, we've had Queensland shutting the border with two cases and New South Wales, thankfully, keeping things open even when cases spiked to 10 or 15 cases. So yeah, it's been very inconsistent actions of government and it is very difficult to predict.
When we put that all together, does that make you bullish or bearish on markets?
That makes me, I think like everybody else, very confused because I think the truth is, as I said, what's happened is some sectors are doing well. Some sectors are not doing well. On the other hand, you've got this deluge of money that's been pumped into the system either by central banks or by governments with their fiscal largesse if you like. On the other hand, the central banks are keeping rates as low as possible.
As I said, it's quite an unusual period because in a sense it's an economic boom in some sectors but a depression in other sectors like travel and hotels. So it's a confusing time.
Again, we saw with the budget yesterday, again a huge budget deficit, all these handouts. Now, at some point, if the economy does pick up, then potentially there could be inflation later on down the track because there's been so much money pumped into the system.
But as I said, it's very unpredictable. Again, if you look at the housing market, it's been very strong. Now, again, in most recessions when unemployment goes up and there's uncertainty amongst investors, house prices normally get the wobbles. In this case, we've seen house prices actually quite strong.
You’re expecting ASX companies to plan for a soft 2021. What does that mean?
What that means is obviously many companies are trying to forecast the next year or two and I guess many of them are as confused as everybody else, quite frankly. And if you're a business leader at the moment looking into 2021, new projects, capital expenditure … there's a bit of hesitancy from a lot of companies because of that uncertainty into 2021.
In fact, a lot of companies are looking perhaps to reduce staff numbers and they're holding back that CapEx, that capital expenditure that they may have gone for in 2021, they're perhaps deferring to wait and see how it eventuates. That's normally not very positive for the economy but, on the other hand, you have the government who is doing lots of things to stimulate the economy.
Is there also a cost-out story as a result?
Yes, 100%. And in fact, there are a couple of cases. I could talk about SkyCity in Auckland which has reduced its staff numbers during the lockdown in Auckland. Now the casino is open and business is doing very well because obviously, New Zealanders can't go anywhere. Those who like to gamble, they're gambling at Sky City in Auckland, and Sky City in Auckland obviously have kept their costs quite low. So, there is that leverage, yes. And at some stage, if that continues, companies will have to start employing people again.
You recently wrote a wire titled ‘A tale of 2 stocks, and what it tells us about the market’. Can you expand on it and give us your view on the technology sector?
It's an asset bubble. It's a technology bubble.
So obviously, low interest rates are good in terms of stimulating the economy in terms of people having to take more risk rather than have their money sitting in cash or term deposits. But I think what it's leading to is some sort of irrational exuberance in some sectors. So if you look at the buy now pay later, if you look at things like Tesla in the US, it's pretty hard I think to justify the prices today. Now, again, the issue with those stocks is they tend to be long-dated.
So I mean, Tesla, what's Tesla worth? I have no idea. Nobody knows how many cars will sell in the future.
It changes wildly every day, doesn’t it?
Well, no, but that's the share price, but in terms of trying to do a forecast, I mean how many cars will Tesla sell in 2030? How many cars will Tesla sell in 2040? You could say five million, one million, ten million. We'll probably all be wrong.
But the point is if you put an optimistic forecast for a stock like Tesla and then you discount it back using current interest rates, you can end up at whatever value you like. So low interest rates also has an impact in terms of the amount of money that's looking for, all this hot money, but also in terms of how you value stocks. It also has an impact on that.
So against that, what are you avoiding in the market? What are you just not wanting to invest in?
Well, technology, again, nothing wrong with technology stocks. Again, as I said, if you look at the US which has got global giants, Facebook and Google and Apple, etc.; all very profitable, all global, all cash on the balance sheet, very different from what we have available in Australia.
You know, there's technology and there's technology.
Look, in Australia, we are, as I said, fairly limited in terms of good quality technology companies. But what we do have is very well managed companies in Australia, good industrial companies. Some of them are global, some of them specialise locally. So,Metcash
, which has been doing very well through the pandemic. It's spent a lot of money in the last few years upgrading its stores, upgrading its systems, bringing its prices to be more competitive with Woolworths, Coles, and Aldi.
And what's happened through the pandemic is the shop local theme. People have been going to their local IGA and they're actually saying, "Well, actually prices aren't that bad and they've actually fixed up the shops." So as things are reopening, what's happening is they found their market share is actually a bit better than it was before the lockdown. So there's a company that's actually benefited in a sense from it.
Then you've got these global stocks which happen to be based in Australia. I mean Amcor is one which is a global leader in flexible and rigid packaging. Orica is another global leader, happens to be listed on Australia, the largest explosives company in the world with operations in North America, South America, Europe, Asia, Africa.
Those sort of companies, they haven't really taken off. People are very cautious about them it seems. As I said, they're very well managed companies. They've got very good balance sheets, a very good track record of producing good cash flow and dividends and those are the sort of things we quite like.
Do you believe that there's actually some inherent superiority with the US tech companies, the FAANGs versus what we've got in Australia?
Yes, yes, I think there is. And I think what's happened ... and again, that's not saying that perhaps one or two of the companies in Australia may be successful globally. It's too early to tell. But again, as I said, those companies in America are global leaders now. They've got cash on the balance sheet. They make lots of money.
The ones we have in Australia, they're more like startup type companies. So while Afterpay is growing, it's still yet to make a profit. While Zip Money is growing ... and again, they're not really technology companies. They're more like credit providers that actually happen to use an app to provide the credit. So again, there's not that much technology involved in what they do. They're just giving people interest-free credit.
But those companies, as I said, Zip and Afterpay, they don't make any money yet. So again, very difficult, when you look at Facebook and Apple and the amount of money that they make, their balance sheets, many of the companies in Australia are at a different stage and not all of them will succeed. In fact, the vast majority of them probably won't.
And is that the big risk?
Yes, 100%. That is the risk, yes. There's excitement and there's a lot of upside potentially if they get it right, although again one would argue that a lot of that upside is captured now. Afterpay's capped at $20 billion dollars which is a lot of money for a company to make a profit.
Are there any technology companies you rate or own in Australia?
How do you define quality in this environment?
What is quality in an environment where cash flows are hard to predict due to stimulus payments and unpredictable around lockdowns?
Look, I think we've always defined quality as companies with a strong, competitive advantage so they're number one or two in their industry and they've got a moat around their business. It's very difficult for new entrants to come in. We like to see the following things in companies:
- No.1 or No. 2 in their sector and industry
- Competitive moats and advantages
- The ability to generate recurring and predictable earnings
- They're run by experienced management who have got a track record of doing things right
- They can grow earnings over time
- Importantly, they're trading at a reasonable value.
Because when tough times do come and they could still come, no one knows as I said, but when they do come, companies that have got that scale and that can operate despite tougher conditions tend to do a lot better than companies in a commodity type business.
The funny thing is even though the market's quite high and hot in some sectors, there's actually quite good value in some of those. We're still finding quite good value. So Aurizon, for example, it's not everyone's cup of tea because they move coal. Well, they own the Queensland Rail system and one of their biggest customers is the coal companies in Queensland.
So some people say, "Oh, coal." They don't touch it but, anyway, be it as it is, Aurizon didn’t' make that choice. It just happens that its rail lines are in Queensland and Queensland's a big exporter of coal. So that company, a good balance sheet, pays a good dividend, a very well-managed company, unique assets, looks very good value.
What other stocks do you like in this environment?
We quite like the casino stocks so SkyCity I mentioned in Auckland, which is now Auckland and Adelaide. That's reopened. Crown is one that's a bit on the nose at the moment for various reasons, partly because the casino in Victoria is closed at the moment, obviously and partly because of the commission going on at the moment in New South Wales, the inquiry that's going on as to whether Crown should hold the licence in New South Wales. So those things are weighing on the stock quite dramatically. But again, if you look at Crown, the properties they own, they own their Burswood property. They own Crown Melbourne. They own Barangaroo. The licences, Melbourne is still 2050, Burswood is still 2066, Barangaroo hasn't started yet, but they'll be till 2112 or whatever, long-dated licences, unique assets, unique licences. We think Crown at the moment, on a three to five-year view, looks pretty good.
Is the office and shopping centre A-REIT business model under siege?
Yeah, it's a difficult one. It's a difficult one. So look, we've stuck to REITs through the last six to twelve months. Really we've stuck to REITs which have had Coles or Woolworths as an anchor tenant; things like Shopping Centres Australasia, Charter Hall Retail. Bunnings Warehouse is one we bought when they fell in March because Wesfarmers is the tenant and they've got long leases. Look, when you come to office trust now, etc. it's confusing because obviously more people are working from home. There will be some pressure on office rents because of perhaps lower demand because possibly unemployment will be higher and also possibly because people won't want to return in a hurry back to offices, right? So it is a difficult one.
Similarly, with retail trusts, like Scentre Group and Vicinity which have got people like David Jones and Myer, which we've sold out of and who are struggling, and a lot of the smaller retailers are struggling a bit. So look, those they're in a pretty grey area. At the moment, we're not really investing in those office trusts and those pure discretionary REITs. We're sticking to the more defensive ones which have got an anchor tenant, they've got a supermarket as an anchor tenant.
Can you quantify what you've done in terms of exposure?
For example, Charter Hall Retail, we probably didn't have any six months ago or whatever and now we've got 1.5% to 2%. Shopping Centres Australasia, we've always liked. Bunnings Warehouse we bought some as they dropped, maybe 1% or 2%. I thought it didn't stay down long enough. And the rest, as I said, we've avoided the Vicinity Group etc. at this stage because the outlook looks pretty tough.
You bought Myer a few years ago but sold out recently at a loss. What happened?
The lesson was the company looked like it was turning around. Actually it didn't, it slowed down. I think we were encouraged and looked forward to Myer moving their online a lot quicker which is what they were planning to do. I think the investment thesis with Myer, apart from the fact that they want to reduce the floor space which they need to do, was also they've got their hidden asset, if you like, is their Myer One database of five million people of which about 2.5-3 million are active, constantly active.
And the thesis was if they could combine that database with an online shopping offer and integrate it, then that could have done very well. In fact, you could imagine through the pandemic how well that's done but it's just taken Myer…
So they failed to execute? What’s the lesson you’ll carry forward from this?
They haven't executed. It's still sort of work in progress many years later when they kept saying the online is at the front of the queue and they want to refine it, et cetera, and it hasn't happened yet as well as it should have.
I think discretionary retailers are always hard to invest in, to be honest, and even the JB Hi-Fis and the Nick Scalis and the Harvey Normans because they are very cyclical. So we tend to try and stay away unless there's a clear turnaround or there's a rollout happening or whatever. The retailers we like to stick with, as I said, are the ones with the more resilient, recurring earnings so things like Metcash.
Coles is one as well we've bought a lot of in the last six months as the stock price fell to sort of 15 bucks and below, and as Wesfarmers sold out. You know, we think Coles looks very good for the next two to three, not just because obviously supermarkets sales are doing well because people are eating more from home, but also their distribution centre network is very antiquated and there's huge potential cost savings from making that more efficient.
My favourite question now. You've got a lot of experience in markets. What would be your words of wisdom to investors who they don't know if the market's going to fall again and have its own second wave?
I'd say try not to worry too much about the overall market. I mean the market will have its gyrations. It will go up and down.
The truth is term deposits you can't really have your money in cash anymore because you earn zero and you have to look to buy assets now to try and earn an income. If you've saved money to earn, to live off the income from that money, you can't do it having it in cash. So you have to look at alternative sources.
So obviously one's got to be careful because you are taking more risk. But as I said, if you look at the stock market, good quality companies, the Coles of this world, the Oricas, the Aurizons, the Cleanaways, the Metcashes, those companies are not going to go away. They're all number one or two or whatever in their industry, or one, two or three in their industry. They've been around a long time. They make very good cash flows. They pay very good dividends.
You have to look at those sort of companies, Amcor's another one, on times of weakness, because the truth is rates are low. They're probably going to stay low for a while because until the economy recovers, the market will be volatile. But as long as you're not chasing the hot sectors and the hot stocks and sticking to good quality companies, I don't think it's a bad time to invest necessarily because rates are so low that it makes the yields and cash flows from those companies look pretty attractive.
Learn more about Anton and IML
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Anton appears to see little value in Australian technology stocks. He argues that good quality companies that have strong cash flows, pay dividends and are leaders in the field are what he is focusing on and, by implication, what other investors should focus on. I agree that good quality companies are what everyone should be investing in. Michael Frazis presents an excellent case as to why many Australian technolgy companies are just that, good quality companies (see https://www.fraziscapitalpartners.com/post/value-is-dead-.... The results of Investor Mutual Funds that presumably shun Australian technology companies and instead invest in other good quality companies have historically not done that well (please see https://iml.com.au/performance/fund-updates). The results for four IML funds are as follows. Investors Mutual Australian Share Fund - 5 years return 4.30%; benchmark 7.40% Investors Mutual All Industrials Share Fund - 5 years return 2.80%; benchmark 6.00% Investors Mutual Concentrated Australian Share Fund - 5 years return 5.70%; benchmark 7.40% Investors Mutual Future Leaders Fund - 5 years return 4.50%; benchmark 11.20%. All four funds have underperformed their respective benchmarks over the last 5 years. It is one thing to advocate investing in good quality companies but if investing in such companies means that a fund cannot beat its own benchmark then something is clearly amiss. Either the companies being invested in are not good quality companies and this is reflected in their share prices or they are good quality companies but many investors would prefer to shun such companies and instead invest in poorer quality, riskier companies where they can outperform. If a person invests in these supposedly inferior companies and consistently outperforms over many years then are these companies actually poorer and riskier? Howard Marks asserts that a person who can consistently beat an index over many years has what he calls alpha, investment skill. My CAGR over the last 11 years avoiding the kinds of good quality companies mentioned in Anton's article is 26%.
With all due respect to Anton, I think he is being a little too harsh on Australian technology companies. There are a small group of wonderful Australian tech world beaters listed on our ASX. They have strong market shares, generate superb levels of free cash flow, spend lots on R&D, reinvest back into the business to maintain and extend their moats and have massively outperformed our Index for a very long time. These sorts of companies will continue to do so.
Thanks for the good interview! Unfair to "grade" a Manager over a 5 year performance period. Far too short a period. IML's view/position has obviously not been helped by the Pandemic, but mean-reversion will befriend their strategy eventually. RE: Peter Brown's 26% p/a for 11 years, huge congrats!! Super impressive. Any themes/strategies/factors you are willing to share to help others improve and lift returns?